VAT and Property – The Option to Tax Commercial Property

Alan J Taylor

The VAT issues surrounding land and property are many and varied but this article is limited to the subject of the Option to Tax – the Option. The sums involved in property deals tend to be large and failure to appreciate the VAT implications can be costly. As VAT is a transaction based tax, it is crucial to get it right at the time – this is not something that can be tidied up at the year end.

The Option is a mechanism that can be used by businesses to convert what would otherwise be VAT exempt supplies into taxable ones. Why would someone want to do this? The answer is normally to be found by looking at the input tax position. The Option, or waiver of exemption as it is also known, is often exercised in order to ensure that VAT costs become recoverable where they would ordinarily be lost.

The simplest example to illustrate how the Option works is the construction of new offices intended for rental. Without an Option the rental receipts would be exempt from VAT with the result that the VAT costs of the construction would be irrecoverable for the developer. If the rents are taxable, following the effective exercise of the Option, the costs incurred by the developer will be recoverable.

A common misconception about the Option is that it automatically flows with the property. This is not the case as each person must consider whether or not they wish to waive exemption of their interest. We might look at a tenant who leases the complete building from the developer and pays VAT on the rent. That tenant may decide to sub-let one floor of the office block as he does not need the whole premises for his day to day business. The rent chargeable by that tenant will be VAT exempt unless he chooses to opt to tax in his own right.

An Option is not always effective. Anti avoidance legislation exists to prevent partially exempt businesses, those unable to recover all of their input tax, from utilising an Option. The impact on the developer of a disapplied Option can be a requirement to pay back all the VAT costs recovered in relation to the development plus an additional knock on negative effect on his overall VAT recovery.

The permission of HM Revenue & Customs (HMRC) may be required before an Option can be exercised. This can involve lengthy negotiations before permission is granted. An Option is usually irrevocable for 20 years and it should not be exercised lightly. The actual decision to exercise the Option is a separate action to that of the formal notification. Timing can be critical. If a business is looking to acquire the freehold of a VAT opted office block with tenants in-situ there is a possibility that a transfer of a going concern exists for VAT purposes. HMRC will see the transfer as one of a property rental business if all the relevant conditions are met including the exercise of the Option by the purchaser. If the Option is not exercised soon enough VAT will be chargeable (with SDLT on top) on the sale of the property. Other business transfers involving Opted property require the Option to be exercised by the purchaser in order to prevent VAT being chargeable on the transfer of the property element.

The Option does not normally affect dwellings or qualifying residential or charitable properties but situations exist where, if both parties agree in writing, the Option can continue to apply even where residential properties are involved. This is where works of conversion are involved but that is a whole new theme and possibly the subject of a future article.

The need to consider the VAT position of any property deal or transaction should be at the forefront of your mind with advice and guidance taken pre rather than post event. It is invariably impossible to turn back the clock!